Our friend Brent Cook recently published this fantastic primer on his process for identifying the few junior exploration companies who stand to generate real returns for investors. It appeared in his Exploration Insights on August 10th, and we believe it is worth the read if you are interested in analyzing resource stocks (edited from the original).
By Brent Cook
Exploration is a tough business, making a discovery is much tougher, and advancing a real deposit through the hurdles of geology, politics, and the stock market is the hardest test and is rarely successful.
In my last letter, I said that we should move ‘down the food chain’ into companies with stellar, early-stage projects that have yet to be tested—a process also much easier said than done. You can always find a reason not to buy.
There are hundreds of properties being explored and drilled by micro-cap junior companies based out of Canada and Australia alone. Almost any one of these could deliver a good drill hole or even a legitimate discovery, but we know the odds of this happening on any single prospect are extremely low; our job is to very critically evaluate the available data, extrapolate that data into the subsurface, and make an educated guess as to the probable drill results. Basically, where could it go right, and what could go wrong?
It’s obviously an advantage knowing what right and wrong look like.
From the first surface samples, we have to imagine building the mine, guesstimate metallurgy, consider infrastructure, and come to terms with the local and regional politics and environmental issues. You also have to consider the company’s technical and financial capabilities, share structure, cash and burn rate… What good is investing if the next capital raise wipes you out?
Here are the initial filters I use before even considering serious due diligence:
- Data and Disclosure:
This is one of the most common failures for exploration companies. Evaluating a project and making an investment decision requires an understanding of the results. Without drill locations and geologic context, I am lost. Longitudinal and cross sections showing all the drill data are also crucial to any interpretation. I figure that the company geologists need this information in a useable format to intelligently plan the next drill hole, hence that data should be available. If it’s not, there’s a problem.
- News releases:
A news release should provide the non-technical reader with a simple but honest assessment of the results, followed by considerable detail for someone more interested in the specifics. “Highlights” are great, but as often as not the important clues are in less exciting results. Too many companies hide or ignore negative drill results, which are critical for serious investors.
- Past work:
Most projects have been explored at some previous time, before the current group got involved. This information generated by previous work should at minimum be referenced and available via maps or technical reports. This information is necessary to either validate or kill the exploration concept.
- Share structure:
Who owns the shares, how liquid are the shares, and how many warrants are outstanding? What was the price of the previous placement and when will that stock become free trading? If stock from a recent placement is about to become free-trading, it can negatively affect the short-term price movement.
- Market capitalization:
What is the price you are paying for the company’s assets and management? A surprising number of companies don’t even provide their share structure on their websites—it’s like walking into a store where nothing is priced.
- Deposit type:
Some geologic settings and deposit types stand a very poor chance of hosting a significant deposit. While samples from a few holes may return excellent grades, certain types of deposit almost always produce small, marginal, or difficult deposits.
This is key: a legitimate company should address ballpark metal recovery from the rock as early as possible. Way too much money is wasted on drilling out resources that cannot be recovered economically.
- The deal:
Excessive land payments, royalties, work commitments, clawback clauses, etc., can prove disastrous to a company, regardless of the property’s merits. Ditto for debt.
Though it is possible to make money off of liars, crooks, cheats, and idiots, I prefer not to deal with them.
Nonetheless, there is no doubt that the mining industry needs new, profitable metal deposits to replace what they are currently mining and that the few successful junior companies will be quite valuable—eventually. In my opinion, if you are very selective in what you buy, diligent in your evaluation and patient enough to allow the exploration process to play out—you stand a good chance of making money in the junior mining sector.
Editor’s note: If you’re interested in hearing more about performing due diligence on resource stocks, download a FREE copy of our Natural Resource Investing Guide, from Rick Rule.
Brent Cook currently authors Exploration Insights, where he analyzes specific companies in the small-cap natural resource sector and serves as an advisor in mining economics and exploration potential for funds and companies. He has worked in over 60 countries across a wide number of geological environments for major mining companies including Kennecott Mining, Rio Tinto Mining, Barrick Gold, and Freeport McMoran.
This letter/article is not intended to meet your specific individual investment needs and it is not tailored to your personal financial situation. Nothing contained herein constitutes, is intended, or deemed to be — either implied or otherwise — investment advice. This letter/article reflects the personal views and opinions of Brent Cook and that is all it purports to be. While the information herein is believed to be accurate and reliable it is not guaranteed or implied to be so. The information herein may not be complete or correct; it is provided in good faith but without any legal responsibility or obligation to provide future updates. Research that was commissioned and paid for by private, institutional clients is deemed to be outside the scope of the newsletter and certain companies that may be discussed in the newsletter could have been the subject of such private research projects done on behalf of private institutional clients. Neither Brent Cook, nor anyone else, accepts any responsibility, or assumes any liability, whatsoever, for any direct, indirect or consequential loss arising from the use of the information in this letter/article. The information contained herein is subject to change without notice, may become outdated and may not be updated. The opinions are both time and market sensitive. Brent Cook, entities that he controls, family, friends, employees, associates, and others may have positions in securities mentioned, or discussed, in this letter/article. While every attempt is made to avoid conflicts of interest, such conflicts do arise from time to time. Whenever a conflict of interest arises, every attempt is made to resolve such conflict in the best possible interest of all parties, but you should not assume that your interest would be placed ahead of anyone else’s interest in the event of a conflict of interest. No part of this letter/article may be reproduced, copied, emailed, faxed, or distributed (in any form) without the express written permission of Brent Cook. Everything contained herein is subject to international copyright protection.